The 1990s were a gift to the U.S. auto industry. Low inflation, low interest rates, cheap gasoline, record vehicle sales, especially large trucks, translated into record profits for each of the American companies. We’ve written in the past that auto companies squandered their cash and wasted time in correcting competitive deficiencies when they had plenty of both. Now the good times are really o" />

Issue: Jun 2004


Keller



The Gathering Storm

by Maryann Keller

The 1990s were a gift to the U.S. auto industry. Low inflation, low interest rates, cheap gasoline, record vehicle sales, especially large trucks, translated into record profits for each of the American companies. We’ve written in the past that auto companies squandered their cash and wasted time in correcting competitive deficiencies when they had plenty of both. Now the good times are really over and just how prepared each company is for a rapid reversal on the energy and economic fronts remains to be seen.

High gasoline prices are headline news and they are having an impact on buyer behavior. It doesn’t matter that gasoline, at just over $2.00 a gallon, is still cheaper than bottled water. Tell me how many people drink 20 or 30 gallons of water each week. Bottled water isn’t a necessity but a car is for most people. Paying $50 to $60 or more to fill up an SUV each week is an expensive reminder that will raise the importance of fuel economy the next time they shop for a car.

Demand for Hummer H2 and other giant “light” trucks is weak and their drivers are getting the kinds of cold stares that women in fur coats got a decade ago. It simply isn’t fashionable to be seen in such a car anymore. Detroit fortunately has some CUVs in its arsenal but it doesn’t have fun-to-drive small cars like the Mini Cooper, the Mazda 3, Scion or the Subaru Forester, which have become darlings of young buyers.

Higher gasoline prices have another consequence to the economy as pointed out recently by Wal-Mart management. They are taking a huge bite out of consumer spending power, which could potentially stall the nascent recovery. We might be willing to spend the extra money fuel, but that means we have less to spend on entertainment, housing, clothes, etc. Furthermore, inflationary pressures are building as every business feels the impact of higher energy prices. It’s going to be harder to extract cost reductions from auto parts suppliers as their raw materials prices, delivery and transportation costs and factory energy costs rise.

Stock markets have been volatile this year as interest rates rise. The massive U.S. budget deficit mandates higher rates to attract investors to buy Treasury bonds. But higher interest rates translate into a higher cost of capital for auto companies, which in turn means that 0 percent car loans will go away. At the same time, car buyers are carrying so much adjustable rate debt that a 100 basis point rise in rates alone would slow the economy to a crawl as their debt carrying obligations increase.

During the last three years, low interest rates enabled homeowners to pull equity out of their home and some of that money was used to buy cars. That equity could disappear if interest rates increase more than 200 basis points. Apart from the fact that consumers are going to be paying more on their adjustable rate mortgages, they will also be confronting the fact that their houses might be worth less than they owe as home values drop.

Detroit has been late to develop and introduce hybrid technology so Honda and especially Toyota have enhanced their reputation for being technology leaders. Fortunately, Ford has the hybrid Escape due out this fall, which puts the company in the game. But GM is still three years away from a full hybrid even though it can claim some mileage gain with its “light” hybrid trucks.

With foreign brands steadily gaining market share, it is inevitable that 2005 will give them an even bigger boost. For too long Detroit played the bigger is better game. That is going to add to the challenge of achieving profit goals over the next year or more.

Maryann Keller is a veteran auto industry analyst and author of the books “Rude Awakening: The Rise, Fall and Struggle to Recover at General Motors” and “Collision: GM, Toyota and Volkswagen and the Race to Own the 21st Century.”

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